The minutes of the monetary policy committee’s Aug 8-10 meeting, released by the Reserve Bank of India this week, showed that most members agreed that food inflation was transient and that the rise could be seen through without any additional tightening.

So, will the MPC stand pat on interest rates in the coming months?

The MPC's decision to hold the rate was announced on August 10, when the data at hand showed that inflation, though rising, was at 4.9% for June. The inflation rate was expected to rise due to a spike in tomato prices to above 6%, the upper end of the MPC’s target band for inflation.

Most economists expected inflation to rise to 6.5%.

However, the actual number for July printed at 7.44%, which stumped the market economists. The number could have indeed surprised the MPC members as well.

This poses two challenges: average inflation could be higher than previous RBI projections, and inflation expectations would go up a notch due to the spike in the headline number.

So, when they meet next between Oct 4 and Oct 6, would the MPC be cool to the prospects of rising inflation and dub it a transient phenomenon, or would they take action to ensure inflationary expectations don’t take root?

The next meeting could be somewhat tricky for the MPC members. They could at least debate the need for a rate hike, even though they may elect to wait out for a couple of months before taking fresh measures.

External MPC member Jayant Varma wrote in the August MPC meeting minutes that “just as a couple of low readings (of inflation) do not call for celebration, it is equally true that a couple of very high readings do not call for panic.” He could probably afford a rethink as the rise in July was sharply higher than expected.

Common Ground

In the August MPC meeting, the six members unanimously voted to keep the repo rate at 6.5%. They also voted 5-1 to keep the policy stance of withdrawing accommodation unchanged.

The common theme for the members was that the rise in inflation was transient.

Some committee members noted that food prices were outside the purview of the MPCs as they could not counter the first-order effects of high food prices with monetary measures.

They, however, noted that the economy faces the risk of generalising price pressures and second-order effects on inflation expectations.

All three RBI members of the MPC, including Governor Shaktikanta Das, flagged the uneven distribution of monsoon rainfall and El Nino as risks to the inflation outlook.

No MPC member appeared unduly concerned about the prospects for economic growth. To that extent, inflation will remain a dominant theme of debate for the Committee.

RBI member Rajiv Ranjan said the “goldilocks” scenario of strong growth and easing inflation, as he had mentioned in the June MPC, still holds good, although there is a transitory spurt in inflation.

Cautionary Tale

The next MPC meeting will likely see more hawkishness from members even if they opt for holding rates again. The RBI had imposed an incremental cash reserve ratio of 10% alongside the MPC decision.

Going by the minutes, Deputy Governor Michael Patra is worried about liquidity fuelling inflation.

He wrote in the minutes that excess liquidity should engage primacy in the attention of the RBI going forward as it presents a direct threat to the central bank’s resolve to bring inflation to the 4% target.

To that extent, the incremental CRR is unlikely to be as temporary as the RBI made it out to be. There are enough hints from the MPC members, despite the overwhelming message to see through the surge in food inflation, that the central bank would act to prevent the second-order effects of high good inflation.

In the global setting, food and other commodities are mixed. Chinese deflation and slow growth are preventing a runaway rise in international prices, although they remain pressured up. As per the minutes, Patra noted that food, metal, and energy prices have destabilised the global inflation environment.

While there is comfort that core inflation is easing, there is a niggling worry that it is still high. High good prices, through wages, transportation, and rent could drive up core inflation again, if inflation expectations remain high.

The biggest challenge for the MPC, however, is the weather. The forecasts of sub-optimal rains and the onset of El Nino have added to the inflationary risks.

As the next MPC nears, the market will start to price in the view that rate hikes cannot be ruled out. They could prefer the MPC to not hike rates and wait it out, but fears of a rate hike could escalate.